Thursday, April 25, 2013

The helping hand of deflation

One of investors’ biggest fears over the
Fed’s monetary stimulus (QE3) is that it will cause runaway inflation. While there are reasons for believing this
fear could come to pass in the years following the upcoming 120-year cycle
bottom in late 2014, the evidence suggests that inflation is not a concern in
the 1-2 years ahead.

It’s remarkable just how quickly those fears
over inflation getting out of hand can change into fears over deflation. Just in the last few weeks we’ve seen
substantial declines in commodity prices, from corn to oil to gold, and
economic forecasters have changed their tune from inflation to deflation. The reason for this is because the 120-year
Kress cycle is in its final deflationary phase and is defeating the central
banks’ strongest attempts at creating inflation.

Take for instance the featured editorial in
the latest issue of Barron’s. Randall Forsyth’s column, entitled “A
Deflationary Wave,” says it all. Forsyth
described the recent commodities rout as being part of a “global deflationary
wave” that has yet to run its course.
While I agree with this statement from a longer-term (1-2 year)
standpoint, the technical indicators suggest a bottom is nigh at hand for this mini-deflationary
wave in the near term.

“The message seems to be,” writes Forsyth,
“that there are limits to central banks’ ability to keep boosting commodities,
which are barometers of the real economy.
And the rocky performance of stocks doesn’t inspire confidence that they
can keep the bull market running indefinitely.”
Again, this statement may be true in the longer term, but the evidence
strongly suggests the Fed’s efforts will prove sufficient to boost equities in
the near term.

Besides providing the market with a much
needed correction, another thing the commodities sell-off succeeded in doing was
relieving the retail economy of some of the excesses from QE3. The recent drop in oil, food and base metals
prices will, in the words of one economist, “give consumers more spending power
and let central bankers keep at their game longer.” In other words, the mini-deflationary wave
that Forsyth wrote about will actually prove beneficial for both consumers and
investors as long as the Fed is going hard and heavy with its $85
billion-a-month asset purchases.